Hawaiian Electric Industries Inc (HE) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter three, 2007 Hawaiian Electric Industries earnings conference call. My name is Denise and I will be your coordinator. At this time all participants are in listen-only mode. We will conduct a question-and-answer session at the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder this call is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms. Suzy Hollinger. Please, proceed, ma'am.

Thank you, Denise. Aloha and good afternoon. Thank you for joining us for an update on HEI. My name is Suzy Hollinger and I'm HEI's Manager of Treasury and Investor Relations. Here with me from senior management and speaking today are Connie Lau, HEI and ASB's President and CEO, Mike May, HECO President and CEO, and Tim Schools, ASB's COO. Eric Yeaman, HEI's Financial Vice President, Treasurer and CFO, Alvin Sakamoto, ASB's Executive Vice President Finance, and Tayne Sekimura, HECO's Financial Vice President, are also on the call today.

Connie will start today's presentation with a few comments on third quarter earnings and the Hawaii economy. Mike will follow with an update on the utilities, Tim will then discuss the Bank and Connie will make some closing remarks. At the end of the presentation we'll open it up for your questions.

Before I hand the call over to Connie, I would like to alert you that forward-looking statements will be made on today's call. Please reference (inaudible) of our third quarter Form 10-Q that was filed this morning for information about forward-looking statements.

Now let me turn the call over to Connie to begin the formal comments.

Thanks, Suzy. Aloha and good afternoon. As you know, one of the key issues for HEI is to obtain recovery for reliability costs and investments incurred at our utilities. This year we had a record four rate cases pending for our utilities. Recently we have seen major actions on this front.

Shortly after quarter end, our PUC issued a proposed final D&O for the 2005 Oahu rate case, which authorizes a lower increase than previously approved in their interim decision. Accordingly, we reserved for the refund in the third quarter impacting earnings by $8.3 million.

In addition to the reserve for the refund, our utility continues to see rising O&M and depreciation expenses, and our Bank's earnings were impacted by the difficult interest rate environment and a provision for loans to a single commercial borrower.

Overall, third quarter net income was down $12.4 million, or $0.16 per share compared with the same quarter of 2006. The financial details of the quarter were included in last night's earnings release and Form 10-Q that was filed this morning. I will assume that most of you had a chance to read through the release so I won't go through it, but would be happy to answer any questions you have at the end of the formal presentation.

On a positive note, after the quarter end, our PUC also issued an interim D&O, for the Oahu 2007 test year rate case, granting an additional $17 million in annual revenue. Mike will discuss more details of these rate cases and other PUC decisions shortly.

Let me now briefly update you on the Hawaii economy. As most of you know, Hawaii experienced solid growth over the last five years. State economists expect growth to moderate to 2.9% in 2007 and 2008, off its 2004 to 2006 peak. The outlook for continued but moderate growth is supported by the expectation for increases in real personal income and jobs, as well as continuing low levels of unemployment. The visitor industry continues to operate at high levels. Although visitor days through September 2007 were down 1.9%, compared to the same period of 2006, visitor expenditures continued at a high level, up 0.6% period over period.

Unlike the recent downturn in mainland construction, Hawaii's construction industry remains healthy. Hotel renovation and industrial commercial construction have been and will continue to be stabilizing factors as residential construction slows. Government construction contracts, primarily federal military housing related construction, are expected to remain in the $850 million to $900 million range for the next several years. The long-term multi-billion-dollar military housing privatization initiative has also added to the industry's strength.

As you can tell from this slide, Oahu home prices are holding steady. Year to date through September 2007, median prices for homes and condos increased 2.2% and 4.8% respectively compared to the same period of 2006. As values have held, we continue to see low delinquency trends in our Bank's residential loan portfolio.

In summary, the Hawaii economy is expected to grow at a moderate pace for the next several years with support from all major sectors.

Now I'd like to ask Mike to update you on the utility.

Thanks, Connie. Aloha and good afternoon. As Connie mentioned, a key objective for the utilities is to obtain recovery of operating costs and investments we are making to maintain and improve reliability. So let me move right to that point.

As a reminder, we had four rate cases in progress in 2007. I am pleased to report that we had major progress on these cases this year. As previously disclosed in April, we wrote off certain plant costs as part of a settlement agreement with a consumer advocate, which paved the way for a timely interim increase of $24.6 million from the PUC. This is for our Big Island utility. And most recently we received a 70 million, or 4.9% increase for our largest utility on Oahu. We began recording additional revenue in late October. The interim decision reflects the terms of a settlement to be reached with the consumer advocate and the Department of Defense, the other parties in the case. The decision also includes a tracking mechanism for pension and post-retirement benefits.

We also received news of a long-awaited final decision for our 2005 Oahu rate case. The proposed final decision authorizes a lower increase of $34 million versus 41 million originally approved when they issued the interim decision in 2005. While we obviously would have preferred that the PUC confirm the original 2000 interim amount, this brings action and much needed closure to this case. Although it was issued as a proposed final decision, as mentioned earlier, we have already accrued the refund. This had a net after-tax impact of $8.3 million in our third quarter earnings. The difference between the 2005 interim and the proposed final decision is solely due to the reversal of their earlier position on the inclusion of the prepaid pension asset in the rate base.

On the positive side, the PUC is upholding its previous approval for recovery of our capital investments and operating costs. The resulting rate increase equals the original settlement agreement between the parties in the case. And going forward, there is an interrelationship between the 2005 and 2007 rate cases. The starting point for our 2007 request was based on the assumption that the full 2005 interim increase remained in place. The settlement agreement with the parties in the case provides that the 2007 should be adjusted to account for the lower 2005 final increase. Still to come is an interim decision for our 2007 Maui County rate request. The statutory deadline for an interim decision on this case is early 2008. Overall, these steps are making progress to improve our returns over time.

Of course, there are still challenges ahead, although the Hawaii economy continues a steady and moderate growth, electric sales aren't growing at the same rate. As should be expected, much of the new commercial construction is substantially more energy efficient. Customers, especially commercial customers, are also making existing facilities more efficient. With tight power generation reserves and increasing environmental concerns, demand side management is an important part of meeting future energy needs. Still, overall demand remains at high levels set several years ago.

The need to meet this demand and spikes in peak demand continues to put pressure on our generating units, especially on Oahu. O&M expenses have increased as a result of high levels of overall loads. And we expect these costs to remain high given our tight reserve margins. To address this, we are continuing to execute our overall strategic plan. This focus is on making needed reliability investments and seeking recovery through the rate case process. I've already discussed the major rate case developments this year. I would also like to highlight a couple of key project approvals by the PUC.

As mentioned last quarter, the PUC has now approved our plans for a new 110-megawatt peaking unit on Oahu, planned to begin in 2009. After an extensive competition process we have now select a biodiesel supplier for this unit. By using a renewable fuel for this dispatchable unit, we can increase our renewable portfolio while also improving our generation reserves.

In October, the PUC also issued a final decision approving our east Oahu transmission project. The first phase of this two-phase project is planned to be completed in 2010. This long planned project will provide increased transmission capacity to about 50% of Oahu's customers, improving reliability and accommodating load growths.

Although our tight generation reserves will continue to put pressure on our operating costs, the rate relief granted this year will help. And we believe the positive interim decisions and approvals of major reliability projects are supportive signals from our regulators.

To sum up, tight generation reserves have continued to result in higher O&M expenses. We are addressing this through the addition of new generation capacity and other reliability investments. At the same time, we are encouraging energy efficiency and load management programs to reduce demand, especially during peak times. We've made substantial progress in recovering increasing costs in our rate case process.

Although we received a favorable proposed decision for our 2005 rate case, we have received positive interim increases for our Hawaii Island and our Oahu utilities. The rate relief in our Maui case is still to come. And major reliability projects have also been approved. Our plan will take several years and involve three of our utilities, but over time we look forward to the improvement in our earnings and we are on track to achieve that goal.

Now I'd like to turn things back to Tim to discuss the Bank.

Thanks, Mike. The volatile market conditions in the third quarter proved challenging for financial institutions. Many banks third quarter earnings were impacted by increased credit costs from deteriorating residential real estate market conditions. In addition, heightened concerns about credit risks caused dislocations in the capital markets and kept deposit and borrowing costs relatively high, negatively impacting net interest margins. Fortunately, Hawaii's residential real estate market remains stable and we have not experienced similar declines in credit quality. While we recorded a provision in the third quarter, largely due to a single commercial credit, we are not seeing a trend, as I will discuss later.

Like other financial institutions, we continue to experience margin compression primarily because of increasing funding costs. Outstanding loans grew by 3.4% during the third quarter. Residential loans grew by 4.8% during the quarter, accounting for most of the growth in total loans. This was driven by the purchase of a package of prime, fixed rate, residential loans as well as organic growth. Purchase loans were underwritten to standards that met or exceeded our internal underwriting guidelines and added geographic diversification to our residential loan portfolio.

Commercial loan balances were relatively flat, while forecasted declines in commercial real estate balances were offset by increases in consumer loan balances and residential real estate. Excluding the purchased loans, growth in outstanding loans would still have been slightly positive. Our outlook is for loan growth to remain modest consistent with the expected moderation of Hawaii's economic growth.

Total deposit balances declined by 1% in the third quarter because of the difficult environment for attracting and retaining deposits. One of our key advantages in competing for customers and deposits remains convenience. Studies show convenience is a key consideration in selecting a primary bank.

During the third quarter we reinforced our position as the most convenient bank in Hawaii by extending most of our branch hours on Oahu until 6:00 or even 7:00 p.m. on weekdays. Comparatively, most of our competitors' branches close by 4:00 p.m. In addition, we have more branches open on Saturdays and Sundays than any other bank in Hawaii.

In September our branches received some of their highest customer service scores ever. We believe this was due in part to this initiative. Reinforcing our position as the most convenient bank in Hawaii, should ultimately lead to deposit growth and the sale of additional products and services.

Our net interest margin in the third quarter was 3%, down from 3.2% in the second quarter. The decline in margin was primarily due to increased funding costs. The outflow of lower cost deposits and shift to higher costing CDs and wholesale borrowings resulted in higher interest expense. In spite of the fed funds rate cut near the end of the quarter, we do not anticipate relief from margin pressure in the near term because of the current market conditions.

This chart shows the treasury curve and the LIBOR swap curve as of the end of September. The LIBOR swap curve, the top curve, is a better indicator of our borrowing costs. The credit crisis caused short-term LIBOR rates to increase, resulting in the kink in the short end of the curve. This point of the curve has the greatest influence on our deposit and short-term borrowing costs. So in spite of the fed rate cut we have not experienced significant relief from the pressure on our funding costs.

At the same time, long-term interest rates fell slightly, following the rate cut because of the outlook for a slowing economy, creating a less favorable environment for our primary earning assets, mortgages, and mortgage-backed securities.

Until the credit situation resolves itself and the curve normalizes we do not anticipate relief from margin pressure. This highlights the continued value of our strategy to build business banking and other business lines which can generate higher yield, shorter duration assets for our balance sheet.

Credit quality remains strong during the quarter due to the continued strength of the local economy. As I noted earlier, the provision recorded during the third quarter was due largely to a commercial borrower for which we provisioned in previous quarters, and is not reflective of any trends in the overall credit quality of our portfolio.

Our credit ratios remain strong, and as the chart shows, our nonperforming asset ratio remains well below that of banks and thrifts. Given the outlook for the Hawaii economy and the health of the local residential real estate market credit quality is expected to remain good. However, factors such as significant growth in the loan portfolio, situations with specific borrowers, or changes in outlook for the economy may cause credit costs to increase.

We are continuing to focus on growing fee income from the increased adoption and use debit and credit cards. The growth rate in fee income from debit card use has exceeded Visa's national averages this year. In the third quarter, income from use of debit cards grew over 13% from the same period last year. As we explained on prior calls, we do not expect the level of noninterest expenses to decline significantly from current levels as we focus on strengthening our risk management and compliance infrastructure. This requires investments in people, systems, and training.

Our overall outlook has not significantly changed since our previous call. We are expecting the difficult interest rate environment to persist. We continue to expect modest growth in the loan portfolio and a challenging deposit gathering environment. Given the outlook for the Hawaii economy, credit quality is expected to remain good.

We continue to focus growing our noninterest sensitive income through initiatives such as our card initiatives, and we will continue to invest in building our infrastructure, particularly around risk management and compliance. Overall we believe that the adherence to our strategic plan is helping us manage through the current environment and will continue to do so. This puts American Savings Bank in the best position to compete and grow.

Now I will turn it back over to Connie to close.

Before I wrap up the presentation, let me comment on the dividends. At 5.4% our dividend yield is attractive, and yesterday our board declared the quarterly dividend of $0.31 per share, payable on November 15th, to shareholders of record on December 11th. We intend to maintain the dividend.

To sum up, third quarter results reflect a refund related to the proposed 2005 rate case decision and key earnings challenges that we have been experiencing for several quarters now. Rate relief for our Big Island and Oahu utilities will help alleviate some of those pressures. Our utilities focus for the rest of the year is on the Maui 2007 rate case, and putting in needed infrastructure to support reliable energy services.

The Bank is managing well through the difficult interest rate environment, and is making necessary investments in its risk management and compliance infrastructure as it transitions to a full-service community bank. This will put the Bank in the best position to continue to compete and grow. We intend to maintain the dividend and are focused on key strategies in each of our core businesses to drive long-term earnings growth to support the dividend and increase shareholder value.

This concludes our formal comments. And we'll be happy to answer any questions you may have.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Dave Parker from Robert W. Baird. Please proceed, sir.

Good morning.

Good morning, David.

Couple questions. First off, do you know what the return on equity was for the utility operations for the trailing 12 months?

Give us just a second here, David.

All right. As you dig that up I will ask the second question. How will the recovery of the biodiesel plant that was just approved, the 110-megawatt plant, is that going to require a rate case, or is there some other recovery mechanism that is going to be used for that?

It will require another rate case. And that would coincide with it going in service in 2009, Dave.

So I assume you'd file that in 2008?

Yes.

As you still dig up that, the ROE, here's a question for Tim. And since I'm not a bank geek, but I guess I sort of understood the net interest income kind of spread, as the fed cuts the rates, I assume, and we see a little bit of a decline in the front end of the yield curve, what is going to make a meaningful difference there to take pressure off?

The first thing I'd point out, it's interesting joining this organization where most of the people that follow it have electric backgrounds, but every bank's balance sheet position differently. First of all, based on the duration of the assets but you also need to look at the products of each bank. Because like on the asset side some banks will have prime-based loans, which tend to be tied more to the fed funds rate and some price loans at -- based on the LIBOR curve.

So it's very important to understand the banks you follow, which assets they're priced off of; which index. And on the liability side, the same thing. Customer deposits tend to be based on the treasury curve, and wholesale borrowing costs tend to be based on the LIBOR curve.

So what we were trying to demonstrate on that one slide is most of our assets, being primarily our mortgage lender, are tied to the 10-year treasury. So that's a good point of reference for our asset side for the most part. We have a small amount of home equity and commercial loans that would be tied to different indices.

On the funding side, probably half of our funding is tied to the LIBOR swap curve, which is the wholesale funding. And that's what we were indicating, that even with the rate cuts that index did not come down. So, I don't know if that answers your question, but even with the secondary rate cut that happened this week. We would expect that's going to help some of the deposit pricing here in the market from customer deposits, but we don't expect it's going to bring down wholesale borrowing rates a great deal.

That helps a lot, Tim, thanks. One question while I've got you on the hot seat. The loan reserve that you took, we don't expect that to reoccur, that was for that one customer that we talked about in the second quarter call, is that correct?

That is correct. When you look at the remaining NPAs, as we showed on that chart, our NPA level remains very low, which is primarily a result of our mortgage mix. Even our past dues and delinquencies while they are up, year over year, they're not up a tremendous amount to require significant reserves. Absent that and Alvin is here, so speak up, Alvin, please. But absent that one commercial credit this quarter had we not had that our reserve would have been minimal to none.

Great.

Dave, this is Tayne. I have the ROEs. This is based on a 12 month ended June 30th, based on a rate making method of calculation. And for HECO Oahu, the ROE is 5.49%. For HELCO, the Big Island utility, 0.42%. And MECO, at 7.58%.

I assume with Mike's answer on the new generation unit, as well as -- I assume that rate case activity is going to continue into the foreseeable future at a pretty robust rate. Is that true?

One could assume that with the capital plan that we have on our horizon, the only way that we get recovery from that is through filing rate cases. So that's a reasonable assumption, Dave.

All right. And my last question -- sorry, had a lot of them there, -- your -- I don't want to call it agenda, but your program to expand biodiesel to start meeting some of the renewable requirements in Hawaii, where do you stand on that Mike?

We've actually entered into -- for the 2,000 unit itself, we will be firing that unit with biodiesel and we've entered into a contract. That contract is before the PUC now for approval. We also have work underway to build a biodiesel facility to convert principally our Maui County assets to biodiesel, and we have negotiations underway for that conversion as well.

If you're successful on all of those, where does that take you as far as meeting your renewable requirements?

It's substantially moves us along that curve. We already are at about 13.8%, which ranks us fourth in the nation, if you take out all the federal hydro projects, which sort of skews the numbers. We are well ahead of our 2010 goal, but undaunted by that we plan to go as aggressively as possible to add the renewable to our renewable portfolio. We would expect -- you can just do the arithmetic. If you're adding approximately -- approaching 150 plus megawatts through biodieseling and a combination of actions moving to 200 that has a substantial impact on improving our renewable numbers.

Right. Great. Thank you. See you in a few days.

Yes, look forward to it, Dave.

And your next question comes from the line of Paul Patterson from Glenrock Associates, please proceed.

Aloha, guys. How are you doing?

Aloha, Paul.

I wanted to sort of go over the rate cases here just to get sort of a crystallized sort of what the amount of relief you've received so far? And then sort of get a picture as to how things are going into '08. We have $24 million that you guys got in April, correct, and $70 million in October?

That is correct.

Then you have a decrease -- could you just remind me exactly annually what the decrease is because of the pension assets finding by the commission?

The decrease is nominally 7 million a year. And when you add the two years since we got the interim decision plus interest that takes to us a pretax of nominally 15 million or after tax of 8.3.

Okay.

Which we have, as indicated, written off in the third quarter.

Okay. So we have about $87 million so far, annually, higher rates. How much would you say because, of course, these have happened throughout the year -- how much would you say that when we go to '08, incrementally we're going to be seeing just as a result of getting $87 million versus what you guys have received so far this year, if you follow me?

Paul this is Tayne and let me help you answer that question. If you take a look at the HELCO rate case, and we can refer to the annual revenues of 24.6 million. After you consider revenue taxes and income taxes, net income impact would be $14 million.

Okay.

For the HECO 2007 case, which we just received an interim of 70 million an annual basis, removing revenue taxes and income taxes brings us to net impact on an annual basis of 39 million.

Okay.

For MECO -- excuse me --

Go ahead, no, I'll let you keep going.

For our MECO 2007 case, after assuming we get our entire request, which was updated to 18.3 million, after you consider revenue taxes and income taxes, that would amount to an annual net income impact of $10 million.

Okay. So, if we take this 39 million and $14 million, how much have you guys already received so far this year, if you follow me, versus what -- what will the incremental impact be in '08 versus '07 since you've already been collecting -- you see what I'm saying?

You started getting a portion of the 14 million in net income in April.

Right.

And you didn't start getting a portion of the 39 million until late October. So you will se a sizable change between what you will get on a partial year basis this year versus full year basis next year.

Right. Okay. Well, I'll go over that with you guys later, I guess. Then did the impact of the $7 million pretax from the pension thing, is that -- should we just tax effect that and assume -- that's effective as of what, as of October?

That was recorded -- the $8.3 million refund net of tax was recorded as third quarter business.

Right. But, I mean, okay, I guess what I'm saying, outside of that one-time item, what was the impact for the fourth quarter? Do you see what I'm saying? What would the impact be? I guess it would be basically $7 million divided by 4, tax effected. Is that pretty much the idea?

Pretty much the impact for the fourth quarter, if we just take a look at the interest portion, from October 1 through October 22nd when we received the interim, that's about $300,000 net income impact.

Okay. Let me just move to the Bank for a second here. The one customer that caused this loan loss reserve, what was it that changed? You guys had a $1.2 million hit, I think from the same customer, if I understand that correctly, now it's a little higher. What is it that had you -- what is it that changed with the customer that made you guys split it up into two quarters, if you follow me?

Basically, this customer is in the construction business, and they had a dispute going with the entity that they were building for, and so it is us watching the dispute and the resolution of the dispute that caused that differential.

Okay. And I guess that dispute has been -- it was resolved one way or the other but the bottom line is there really shouldn't be any more downside from that, if I understand correctly?

Actually, the dispute is still ongoing, but we have reserved for that loan.

Okay. Fully. So when we go to the --

Well, it's a roughly $6 million loan. I think about $5 million has been reserved. So there's $1 million at this point that's not reserved. But what you do as you go through this process is you evaluate the quality and ability of your collateral. And so at this point, based on what we perceive the risk of loss to be and the value of the collateral, we feel that our risk has been provisioned.

Looked to me like it was 3.9 million. You say it's more like 5 million?

Well, we had done some in the previous quarter.

I thought that included -- I've got 3.9 million for the nine months.

And previous in the year as well. So it's been building up to where it's about a $6 million relationship with this customer and about 5 million has now been provisioned in total.

Okay, great. Then the compensation and employee benefits seemed to go down this quarter at the bank, and just in general it seems that there was maybe, if I'm reading the income statement correctly, that there was a bit of a slight decrease in the noninterest expense, which as you mentioned has been increasing a lot. You made some comments that might continue to increase but the trend may not change. Just wondering, are we sort of at the inflexion point here or are we at a point where this growth won't be as aggressive? You mentioned you guys were still going to build it up. Just wondering if you could comment on that? Because it did seem there was a decrease in compensation, employee benefits and --

Sure.

Okay. Paul, we're actually in full buildout now on the risk management and compliance area, so that's why we talked about we don't expect those levels to drop. For the third quarter, however, and looking at the outlook for the year, with the margin compression then this extra provisioning that we've had to do for this commercial borrower, the drop in the compensation and benefits line was actually a reversal of the accruals that we have been making throughout the year for incentive compensation.

Sorry, I didn't follow through. Why was there reversal in that?

Because we assume, as we go through the year that we would earn incentives that target. We've been accruing them all year long.

I got it. I'm sorry. Thank you.

We're going fall short.

I appreciate that. Thank you very much.

Unfortunately management takes the hit on these things.

Thank you.

And your next question comes from the line of Doug Fischer from Wachovia. Please proceed.

Hello.

Hi, Doug.

Good morning, Doug.

Hello Connie, hello, Mike. A few questions. Some time ago there had been some noise around fuel cost recovery in the state. Could you update us on where the commission stands on that issue? And then what kind of overall price increases or -- can you -- have customers experienced from the run up in oil plus the base rate increases? And is that having a significant impact on uncollectibles, et cetera? Is that an issue both from a cash standpoint and an earnings standpoint?

To answer your second question, we have probably one of the lowest uncollectibles in the industry. That has not been a pattern or a concern for the Company. As far as the ECAC, when the Act 162 was passed a few years ago, the state legislature required that the Public Utility Commission must look at the effects of ECAC in each rate case decision.

As part of the settlement agreement, both -- there were two parties to our rate cases. The Department of Defense being a large customer, and the consumer advocate representing the residential ratepayer, if you will. Both were in agreement on the ECAC. That ECAC decision was upheld in the 2006 HELCO rate case, which we received a decision on in April. It was upheld in the 2005 decision.

There are still conditions that the commission are required to look at, and we believe they will continue to be looked at in each rate proceeding as we go forward. But that is the current status. As you may recall, there were five conditions. One was that we fairly share the risk of fuel charges. The intent was to incentivize the utility to lower fuel costs to encourage renewable energy.

Well, as you have already heard, I think we are on an aggressive path toward renewable energy, and would well expect to exceed our 2010 goals and certainly wouldn't be stopped by that goal. That we're going to the fullest extent we can to allow to us mitigate risks that cannot be mitigated by other means, to preserve the utility's financial integrity, and to minimize the need for frequent rate cases. Those were the conditions that were laid out in that legislative action.

So that is the status of where it has come out on each rate case, and that is the framework in which it has been reviewed.

And would kind of rate escalation is the customer seeing, say, for example, on Oahu? Given the run up in oil prices or maybe this latest bump-up hasn't been reflected yet in the prices you're paying, and how big of a concern is that?

Let me answer that. A typical bill for our customers, as you may recall, unlike the mainland, we don't have a lot of air conditioning, and we certainly don't have a heating load. So we typically have a customer that is less than 700 kilowatt hours a month. They will be paying a bill of $136 per month, and if you compare that to October of last year, it was $119 a month. So from 136 -- from 119 to 136 is the typical bill.

And I'm seeing that the average fuel cost, I guess, for the three months ended September 30th, was about -- cost per barrel was about $75. So one would expect that to escalate, given what's going on in the commodity markets, or is there a difference?

We don't track exactly on a -- we track more on a lag basis. Our contracts don't work on a spot market base but more on a lag basis. But the general movement would reflect what you're seeing in the market.

Okay. And then can you -- one last question about the recovery of these prepaid pension costs or the fact that they were removed from rate base, and obviously you have some kind of mechanism in this new interim settlement. Talk to us about whether you're happy with where you're at on that? And why maybe the commission reversed itself, at least on an interim basis?

Let me give you some background on the case itself. In terms of the reason for the reversal. Basically, in the commission's decision, they spoke about the prepaid pension asset and how it was built up over the years. They talked about HECO shareholders not providing the funds that represented this prepaid pension asset.

And as a reminder, the prepaid pension asset is accumulation of the contributions to the pension trust which is in excess of your pension cost. And they did speak to the time between 1999 through 2002 which contributed to increases in our prepaid pension due to favorable market conditions, and because of this, HECO's shareholders should not be entitled to earn a return on this asset. That was the basis of the reversal of that decision.

And then the mechanism you have now in the interim?

In the settlement agreement, the parties to the case agreed that in the final decision in the 2005 case, it may affect the amount of increase that was determined in the 2007 case and that that interim decision should be adjusted when the final rates are taken into account. And so, therefore, it's logical for the 2007 increase to be adjusted and that's what we're working on right now.

Okay. Thank you for your answers.

Before we take another question, I just wanted to apologize for a misspeak that I had earlier on the dividend. It's actually payable to shareholders of record on November 15th and payable on December 11th.

And your next question comes from the line of Steve Gambuzza from Longbow Capital. Please proceed.

Hi, how are you?

Hi, Steve.

The numbers that you gave for the kind of full-year impact of the rate relief; 24 million dropping to 14 million net income and 70 million dropping to 39 million. What type of cost increases, net of loan growth -- how should we think about the effect of rising costs against that rate relief? What type of cost creep are you experiencing that will erode the net income benefit of that relief and is that -- will that be offset by load growth, or is that kind of -- do you use forecasted loads to get to those numbers?

The rate case does make an attempt to approximate what your load profile will look like to arrive at your ultimate rate decision. So there's some of that reflected in there. We would also expect to see that some of the expenses that we have been incurring this year, which were not covered by rates, we would expect to be picked up by the rate case changes that will go into effect.

What we're experiencing as probably is the case throughout America, is that as we're doing our electrical project -- our construction projects, we're seeing just huge run ups in everything from our labor availability and commodity pricing costs. Steel, aluminum, copper, just to mention a few, are hitting astronomical levels.

I might add just anecdotally, to the point where one of the major issues we're facing right now is copper theft. People literally taking down, stealing, breaking in transformers to steal copper.

So those are things that we would expect to escalate the cost of our projects as we go forward. But as I commented earlier, we would also expect, as we get those final capital projects in place, we would seek recovery through a possible rate action in the future.

So what was the test year for the $70 million of relief that you achieved in October?

That was based on the 2007 test year.

So I guess, really my question is what -- if you expect these cost pressures to emerge in 2008, the $39 million full-year benefit that you would get from this rate impact would be offset by the rising costs that you experienced in 2008?

That's correct.

And --

I was wondering if could you give some color on what those cost factors might be? I know you've been experiencing very sharp increases in plant related O&M expenses due to various factors you mentioned, but I would imagine that we've kind of reached a new level on these O&Ms and the expansion growth should moderate, or do you think we'll continue to see sharp increases?

Well, as we've been saying with the addition of more capacity, we would certainly expect those expenses to start moderating. Because what's happening now is we're having to do such extensive O&M work just to keep ourselves on-line and available, we would expect that to moderate with additional reserve capacity.

In other words, would you expect your O&M growth rate to decline, not the O&M cost to go down in '08, but the rate of growth to decline in '08 versus '07?

Really '09 when the new unit comes on.

So would you expect '08 to be another year of very high O&M growth for generation?

Some of which we've tried to capture in the rate case. In other words, the gap we've seen this year between O&M and what we've recovered in rates, but we would expect another tranche, another increment still to occur.

If the rate case is using a 2007 test year, how could you capture the '08 increase in it?

You don't. That's what I'm saying. We would expect to cover the costs that are uncovered this year, but we'd expect to have some incremental adjustments for next year.

Thank you very much.

And your next question comes from the line of [Neal Stanes] from [Eleven] Capital. Please proceed.

Yes, hi, thanks very much. Had a couple questions for you, primarily on the dividend. Can you remind me how your dividend is funded, the breakdown between funding from the DRIP and then funding from the utility, and I guess a portion is funded from the bank as well?

Sure. Basically all of the earnings from the Bank are dividend up to the holding company, and then HECO reinstated payment dividend in the third quarter to HEI, and then effectively, we are issuing DRIP. And DRIP based upon 2005-2006 activity, ranges between 40 and $50 million a year. So the sum of all that is basically how we cover the dividend.

What's the total annual amount in terms of millions for the dividend?

Just slightly over 100 million.

Okay. So roughly the DRIP covers half and then the Bank dividend covers the other half? Is that --

That's correct.

I'm not very familiar with the regulatory restrictions surrounding banks and dividends that banks could pay, but what are those regulatory restrictions that would govern the maximum amount of cash could you pull out of the bank each year?

Basically, what we have to do is make sure that the bank remains safe and sound, and so different banks have different capital ratios. But we've agreed with our regulators that the target capital ratio for American should be 7.5% tier 1 capital. So in the summer of last year, as we were going through the transformation process, we actually reached that target capital level we had been building up the capital level, and so once we reached the target, then we're able to dividend earnings above that capital level.

I see. What makes you comfortable going forward that, I guess you'll be able to continue meeting that test?

Actually we review that target capital ratio continually in our annual planning cycle and that capital level actually tends to be a little bit higher than some of our peers, primarily because we look to offset the composition of our assets where we have a lot of long mortgages, which creates interest rate risk, and so that's the reason why we maintain a slightly higher capital level.

Based on the Bank's growth rate, I think I've explained in previous calls, is that we actually have a fairly large securities portfolio. And so we actually have been shifting the asset mix from the securities portfolio to the loan portfolio, which is a higher yielding asset. And so that doesn't actually require us to carry additional capital. We're just able to fund it through as our securities run off, it helps us pick up the loan growth.

So as we look forward, we should be able to maintain that capital level without any problem. I mean, right now, we're dividending up everything above the 7.5. So should we need it, we would just keep slightly more. But it doesn't appear that we would need significant levels because, as I mentioned, we really can fund our loan growth through the securities portfolio, then also deposit growth.

I suppose is there, I imagine you do different scenario analyses. Is there room for any deterioration in your loan portfolio from the perspective of maintaining the current level of the dividend payout? I'm not -- I'll probably need to follow up with a lot of this off-line, but that would be the question I would ask.

Well, you are correct that if we had major deterioration in the loan portfolio every time we provision, as we had to provision this year for that one commercial borrower, it does impact net income, which in turn would impact the amount that we can dividend up. But, as Tim commented earlier, the Hawaii market, which most of our loans are based here in Hawaii, has remained actually pretty solid. And as we mentioned, had we not had to provision for the one commercial borrower, actually our provision for this year would be pretty nominal, if anything.

And if it ever did come down to it, could you ever go to your regulators and say we need a little bit of flexibility here, we need to pay our dividend? Or, are they generally pretty firm on these sort of metrics that they want to hold you to?

No, actually, as I mentioned at the very start, different banks have different capital ratios. And this is the one that we have set internally when we look at the profile of our balance sheet as what's necessary to balance off our interest rate risk and possible credit risk. And, they -- because they don't set our -- they don't set our capital level. What regulators do have are minimum capital levels, but we are well above the minimum capital levels.

Okay. Thank you very much, and look forward to seeing you next week.

Thanks.

(OPERATOR INSTRUCTIONS) At this time we have no further questions in queue. I would now like to turn the presentation back over to Ms. Suzy Hollinger. Please proceed.

Thanks, everyone, for being on the call. If you have any follow-on questions, please call me at 808-543-7385. See you at EEI.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.